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Last week, I blogged about practices implemented to ensure that performance awards to executives were exempt from Section 162(m). Now that there is no exemption for future grants of performance awards, these practices are theoretically no longer necessary. But, as it turned out, there are other reasons to continue all of the practices I looked at.
This week I look at three 162(m) requirements where there is reason to believe that practices will eventually change. [Don’t think that this completes the list of 162(m) requirements—I could get several more blog entries out of this topic and probably will.]
For prior grants of stock options and performance awards to be exempt under Section 162(m), the plan had to impose a limit (in addition to the shares authorized for grant) on the number of shares that could be granted or maximum compensation that could be paid to an individual employee over a specified period of time. These limits sometimes proved challenging to comply with (see “Oops, Again!”).
Now companies may eventually be able to remove per-person limits from their plans. There’s certainly no other tax or accounting purpose for which the limit is necessary. It’s possible that the limits are useful from a legal standpoint, particularly in light of the suits recently brought by the plaintiffs’ bar over limits on director compensation. I also have to wonder if ISS and other proxy advisors will pick up the baton here and start requiring appropriate limits on awards to executives. Up until now, they haven’t shown much interest in individual limits; perhaps they feel that limited share reserves are sufficient to address any corporate governance considerations.
For performance awards to be exempt, companies either had to state the specific performance measures that awards would be tied to or provide a list of possible metrics. The result of this requirement is that most plans include a laundry list of every possible metric the board can think of.
While I don’t necessarily think companies will be in rush on this, I expect that plans of the future will eliminate these lists in favor of much less specific language. I don’t think these lists served any purpose other than ensuring an exemption from 162(m); they were so broad that I can’t imagine they were useful to shareholders. Moreover, the current proxy disclosure rules have given shareholders much better visibility into the actual metrics used to evaluate executive performance while Say-on-Pay has given them a voice on this.
Where a plan under which performance awards were granted included a list of possible metrics that the awards would be tied to (rather than stating the specific metrics), the plan had to be approved by shareholders every five years. This requirement will also fall by the wayside.
Those companies lucky enough to have sufficient shares that their reserve can last for more than five years will no longer have to submit their plans to shareholder approval solely for purposes of Section 162(m). Of course, this is probably a minority of companies. Most companies have only a few years’ worth of shares in their reserve and will still need to seek approval for additional shares with regularity. Less than a quarter of respondents to the NASPP/Deloitte Consulting 2016 Domestic Stock Plan Design expected to be able to wait more than four years before requesting additional shares for their plan and 62% expected to have to request additional shares within the next one to three years.
As I noted last week, none of this applies to currently outstanding performance awards, especially those granted on or before November 2, 2017. While all the requirements I discuss here are usually stipulated under the plan, rather than the specific terms of the award, it is currently unclear as to whether the plan can be amended to remove these provisions while grandfathered awards are still outstanding. Consult your tax advisors before making any changes to your plan. It may also be wise to wait for guidance from the IRS.
Section 162(m) and the TCJA
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